Morgan Stanley (MS) may have escaped a three-notch downgrade by Moody's in Thursday's downgrade announcement, but the market's opinion has not changed: Morgan Stanley's senior unsecured debt should be "junk" rated.
Across the board, Morgan Stanley's senior unsecured bonds are trading at yields and spreads that indicate the credit rating could easily be Ba1 (highest non-investment grade), or perhaps even lower, rather than the current Baa1 rating they are assigned. When screening the market for corporate bonds with similar call features and maturities as Morgan Stanley's, I found hundreds of bonds with ratings of Baa3 or lower yielding roughly the same as or less than those of Morgan Stanley. In many cases, the bonds I found had ratings of Ba1 or lower ("junk" bonds). I even came across a couple B1 rated, senior unsecured, Ally Financial bonds yielding less than corresponding Morgan Stanley notes. Is the market really saying Ally Financial has a lower credit risk than Morgan Stanley? I also found numerous other single B-rated corporate bonds with similar maturity profiles yielding less than those of Morgan Stanley.
When comparing Morgan Stanley's bonds to those of Bank of America (BAC), another bank whose credit rating was downgraded by Moody's on Thursday, the market is also indicating Morgan Stanley is overrated. Bank of America's senior unsecured notes were downgraded to Baa2 by Moody's, one notch below those of Morgan Stanley. Yet Bank of America's bonds are, across the board, yielding less than Morgan Stanley's, despite the lower credit rating. The market is clearly saying that Moody's still has some work to do with regard to Morgan Stanley's senior unsecured debt rating.
It should be noted that Morgan Stanley is not the only bank for whom the market disagrees with the rating. The same can be said for Bank of America and Goldman Sachs (GS), just not to the same extent as Morgan Stanley. Late last year, I could have included Citigroup (C) and JPMorgan (JPM) in the list, but to a large extent the yields for those banks have come more in line with the ratings, especially after the recent downgrades.
On a final note, I'd like to address some of the media reports I've come across discussing the "rally" in bank bonds after the Moody's downgrades. While there may be a rally in the credit default swaps, the corporate bonds, despite press reports to the contrary, are largely trading in the same ranges they were trading before the downgrades. Corporate bonds often trade in several point ranges on any given day. This isn't necessarily because of a bid or ask price that moves widely as the day progresses, but rather because of commissions/markups, etc. In other words, if you aren't actively following the bid/ask in the market but are just focusing on the last price traded, you might not realize that the trade was far away from the market due, for instance, to a large markup.
When it comes to the aforementioned recently downgraded banks, contrary to what the financial press has been reporting, I'm not seeing an across-the-board, noteworthy rally in the bonds. I have yet to find a senior unsecured bond of one of the downgraded banks mentioned in this article that moved in price into a new higher range than it was trading in before the downgrade. I could easily cherry pick a price at the low end of the range pre-downgrade and cherry pick a price on the higher end of the range post-downgrade, do this across several bonds, and claim there is a widespread rally in bank bonds today. But that wouldn't be an honest way to present today's bank bond moves.
The bottom line is that the recent downgrades by Moody's have thus far caused very little reaction in the bond market, and the ratings agencies, in general, are still behind the curve with respect to how the market views Morgan Stanley and, to some extent, Bank of America and Goldman Sachs. Perhaps, rather than spending their time attempting to spin the Moody's downgrades as positive, analysts and the media would be better suited attempting to figure out why the corporate bond market is pricing the bonds of certain financial institutions as if the ratings need to come down even more. More specifically, spending some time thinking through why the market is pricing Morgan Stanley bonds as if they are "junk" might be more productive than the usual bad news is good news spin we've all become so accustomed to.